1. (SBU) Summary. Per ref A request, the responses below
provide detailed economic and policy information regarding
Spain in advance of the April 2 London Summit. President
Zapatero has made it a matter of national pride to be
included in the G-20 financial discussions, and has spoken
often of the importance of coordinated EU -US action in
facing the financial crisis. Spain has the world's eighth
largest economy, is the second largest international tourism
destination, and is the eighth largest auto manufacturer.
The past 15 years have been characterized by rapid economic
growth, which came to an end starting in late 2007 with
Spain's domestic property crash. The credit crisis and
economic slowdown aggravated this downturn, but Spain's
financial institutions have managed to fare somewhat better
than their European counterparts, posting profits in 2008.
The GOS's number one concern is unemployment, which at 14.4
percent (and growing), is the highest in the EU. End Summary.

2. (U) The comments below are keyed to the questions in
paragraph 5 of ref A.

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SUMMARY OF KEY ISSUES
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3. (SBU) STIMULUS MEASURES: The GOS has implemented two major
stimulus packages including a 18 billion euro tax rebate and
relief package in April and an 11 billion euro infrastructure
investment package in November. We are not aware of any
other stimulus packages being considered, and in fact the GOS
is constrained in its ability to propose additional stimulus
packages due to its deteriorating public finance situation.
The GOS ran a 3.8 percent budget deficit in 2008, and under
current spending scenarios is expected to run a 5.8 percent
deficit in 2009.

Details on the two stimulus packages:
-Tax Relief Stimulus package: Proposed in April 2008, 10
billion is for 2008, and 8 billion is for 2009. The 10
billion in 2008 includes household refunds of 400 euros per
household (6 billion), business loans (2 billion), and
financing for government protected housing (2 billion). The
8 billion for 2009 is for wealth tax reduction (2 billion)
and VAT tax advances (6 billion).

-Infrastructure Relief Stimulus package: 10.85 billion in
total to be spent in 2009, 8 billion for municipal
governments for new infrastructure projects, 2.85 billion for
miscellaneous spending including auto sector loans and
support, and environmental initiatives.

4. (SBU) FINANCIAL SECTOR/APPROACH TO BAD ASSETS: Spanish
financial institutions were not exposed to U.S. subprime
mortgage-related instruments, but they have been exposed to
bad assets related to the domestic housing market downturn.
On March 4, Standard & Poor's lowered the long-term counter
party credit rating on several of Spain's most prominent
financial institutions including Caja Madrid, Banco Sabadell,
and Banco Popular. Standard & Poor's maintained its rating
for Spain's largest banks, Santander and BBVA, but changed
the 2-year perspective on those two banks from "stable" to
"negative." Despite this, Spanish banks appear to be in
better shape than their counterparts in other countries, and

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posted profits in 2008. In response to the freezing of
international credit markets, the GOS has begun to purchase
high quality mortgage-backed assets from banks (in segmented
amounts that may eventually total 50 billion) and to
guarantee up to 100 billion euros in new bank debt. The GOS
also took steps to give the government the authority to
inject capital into banks, though both the GOS and the banks
insist this will not be necessary.

5. (SBU) REAL ECONOMY/SENSITIVE AND VULNERABLE SECTORS:
Minister of Industry Miguel Sebastian has urged Spaniards to
buy Spanish products, but despite these comments,
protectionist actions have not been a factor during this
crisis. Two of Spain's most vulnerable sectors are the
residential construction sector, which represented 10 percent
of GDP in 2006 and is now grinding to a halt, and the auto
sector, which employs 70,000 directly and contributes 2-5
percent of GDP. Regarding the auto sector, the GOS has
introduced measures to stimulate lending, including 1.2
billion euros in state credit for those wishing to replace
older cars with new environmentally friendly cars, and 800
million euros for carmakers to implement "innovative"
production upgrades. Additionally, car makers will be able
to defer social security contributions in 2009, and are able
to partake of state low-cost credit lines for small and
medium-sized firms.

6. (SBU) SOCIAL/LABOR IMPACT: With almost 3.5 million jobless
workers according to the latest figures, Spain's unemployment
rate of 14.4 percent in January is the highest in the
European Union. Unemployment has become the GOS's number one
concern, but President Zapatero has refused to consider
increasing flexibility of hiring and firing. The level of
unemployment benefits varies depending on prior salary of the
laid-off worker, but benefits are usually provided for a
period of up to two years. The GOS has introduced modest
measures (100-400 million euros) to provide incentives for
businesses to retrain and hire unemployed workers, as well as
measures to assist some unemployed workers with mortgage
payments. There have been sporadic strikes, especially on
the part of auto and other manufacturing workers, but
generally speaking, protest activity has not been high.
Unemployment benefits are considered to be generous relative
to other countries and often last up to two years.

7. (SBU) DIMENSIONS OF THE CRISIS: Spain's economy contracted
in Q3 (-0.2) and Q4 (-1.0) of 2008, placing Spain officially
in a recession. The GOS forecasts growth for 2009 at
negative 1.6 percent and has begun to follow the lead of
others in expressing concern about economic prospects for
2010. One prominent business association projects negative
2.8 percent growth for 2009. Spain's number one concern is
unemployment, which the GOS estimates will be 15.9 percent by
the end of 2009, but which independent analysts suggest will
be closer to 20 percent. On the broader international arena,
Spain is concerned about international issues of poverty and
of food security, and has pledged a goal of providing 0.7
percent of its GDP as foreign assistance by 2012. During the
Madrid food security conference in January 26-27, the GOS
pledged new resources for food security including 1 billion
euros over the next five years. Exposure of cross-border
financial institutions, such as Santander and BBVA, is mainly
in Latin American markets, although both have significant
assets in the US.

8. (SBU) G-20 ROLE AND PERCEPTIONS: The GOS is extremely
interested in obtaining permanent Spanish G-20 membership,
and has indicated that it wants consultations with G-20
members about joining (ref C). President Zapatero has made it
a matter of national pride to be included in the G-20
financial discussions, and has often spoken of the importance
of coordinated EU-US action in facing the financial crisis.

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Perceptions of the G-20 process are generally neutral.
However, Presidency economic advisor Javier Valles conveyed
doubts in a January 27 meeting about the progress likely to
be made by April on the reform agenda agreed to in November.

9. (SBU) OBJECTIVES FOR LONDON SUMMIT (Questions A-D): Of
significant importance to the GOS is that it be perceived
both domestically and internationally as a "serious player"
in these economic discussions, and that it ultimately gain
permanent Spanish G-20 membership. Recent media reports
indicate that Spain has an interest in addressing tax havens.
Additionally, the media reported March 4 that the GOS had
sent 10 proposals to London in preparation for the G-20
summit. Included were the following recommendations:

-Increasing transparency of banking institutions and the
markets
-Establishing information requirements for high-risk funds
and instituting measures to track transactions
-Establishing counter-cyclical provisioning requirements
-Improving international accounting standards
-Increasing transparency rights for banking clients
-Limiting the salaries of bank executives
-Increasing payments to the IMF
-Increasing role of IMF as a international financial
supervisor
-Provisions regarding an increased role of multilateral banks

10. The GOS is very keen to advocate banking regulation
reforms consistent with its own Bank of Spain's strict rules.
Spain's conservative banking regulations, including
requiring higher reserve provisioning in good times and
strict accounting rules, have contributed to the relative
stability of Spain's financial institutions. It should be
noted that Second Vice President and Minister of
Economy/Finance Pedro Solbes was not invited to accompany
Zapatero to the Summit although his counterparts from G-20
countries were invited.

11. (SBU) Although downplayed to the general public, one of
the GOS's greatest concerns is the collapse of its housing
market, which fueled approximately 10 percent of GDP as
recently as 2006. Higher interest rates contributed to a
collapse in demand for new homes in mid-2007 that in turn
bankrupted many prominent real estate developers. The glut
of unsold units on the market continues to grow with prices
declining significantly. The global financial crisis
aggravated this collapse in demand. The country's very high
current account deficit means that Spain is dependent on
scarce cross-border lending, and over the past year it has
been more difficult for Spanish institutions to obtain and
lend funds. The largest and most stable institutions have
been able to obtain funds, though at relatively high spreads.

12. (SBU) Despite serious economic difficulties, Spain has
not faced the same financial turmoil that other developed
countries have seen, and many of its private banks posted
profits in 2008. This is partly due to the Bank of Spain's
cautious regulation, but is also because as a net capital
importer (with a large current account deficit), few Spanish
financial institutions invested in U.S. mortgage-based
securities.

MADRID 00000240 004.2 OF 006

13. (SBU) Although many banks have problem loans to troubled
construction and real estate companies, there have been
relatively few mortgage defaults so far, and no Spanish banks
have gone under. That being said, delinquencies are
increasing and Spanish financial institutions are beginning
to show signs of a weakening position. On March 4, Standard
& Poor's rating agency lowered the long-term counter party
credit rating on several of Spain's most prominent financial
institutions including Caja Madrid, Banco Sabadell, and Banco
Popular. Standard & Poor's maintained its rating for Spain's
two largest banks, Santander and BBVA, but changed the 2-year
perspective on those financial institutions from "stable" to
"negative." Moreover, there are expectations that many of
the small savings banks, many of which were heavily exposed
to the troubled construction and real estate companies, will
experience difficulties and begin to merge. Two small
savings banks in the Castilla La Mancha region (Caja Rural de
Alabacete and Caja Rural de Toledo) announced January 8 that
they would merge, and this has been followed by news of other
potential mergers.

14. (SBU) Since September, the GOS has increased deposit
insurance (reluctantly, as a result of other countries'
increases) and announced plans to buy Spanish banks' high
quality mortgaged-back assets (in segmented amounts that will
total 50 billion euros), guarantee new debt (up to 100
billion euros), and inject capital if necessary. Banks'
reactions have been mixed. Neither the GOS nor the banks say
the new capital is needed. However, it appears that banks
are actively seeking GOS guarantees for their new lending.
The GOS has worked hard to promote new bank lending to small
and medium-sized businesses.

15. (SBU) Over the past several months, consumption has
stagnated and the Spanish economy has spiraled downwards.
The National Statistics Institute (INE) confirmed February 12
that the Spanish economy had contracted by 1 percent in the
fourth quarter of 2008, marking the second consecutive
quarter of negative growth and officially placing Spain in a
recession for the first time since 1993. Unemployment spiked
to 14.4 percent in December according to Eurostat, making
Spain the country with the highest level of unemployment in
the EU.

16. (SBU) Spain's trade deficit declined by 4.9 percent in
2008 due largely to falling consumption and imports that
reflect the contracting economy. Exports have also declined
as global demand shrinks, and workers in that field,
particularly in the auto industry, have been especially
affected. Spain is the world's eighth largest automobile
producer, and 80 percent of vehicles produced are exported.
The GOS has introduced measures to stimulate lending,
including 1.2 billion euros in state credit for those wishing
to replace older cars with new environmentally friendly cars,
and 800 million euros for carmakers to implement "innovative"
production upgrades. Additionally, car makers will be able
to defer social security contributions in 2009, and are able
to partake of state low-cost credit lines for small and
medium-sized firms.

17. (SBU) The government continues to support international
trade and to seek to attract foreign investment, and major
Spanish companies continue to invest heavily overseas,
especially in Latin America. The government and population,
while increasingly concerned about immigration in the face of
severe job losses, do not appear to be turning against
international trade. However, the Minister of Industry,

MADRID 00000240 005.2 OF 006

Tourism and Trade has on several recent occasions called on
consumers to purchase domestically manufactured goods and
services and to vacation in Spain rather than abroad as a way
to boost the Spanish economy. That said, post is not aware
of any new proposed tariff hikes or other trade restrictions
or discrimination against foreign investors. Post does not
believe the government is considering capital controls, nor
does it appear to be easing investment restrictions.

18. (SBU) Post is not aware of specific local preferences in
the GOS stimulus measures, though Spanish companies often
have the inside track on infrastructure construction projects
and foreign companies have a hard time competing. Spain uses
the euro and is not attempting to influence its value.

19. (SBU) ECONOMIC OUTLOOK (QUESTION L): The GOS acknowledges
that 2009 will be a difficult year, during which unemployment
will continue to rise, and the recession will continue to
endure, and has begun to express concern for 2010. With
close to 3.5 million jobless workers, unemployment will
continue to be the GOS's number one concern. Many analysts
say that the GOS forecast that unemployment will reach 15.9
percent by year end is unrealistically low. Spain's fiscal
position continues to weaken; the budget deficit was over 3
percent GDP in 2008 and will potentially reach 6 percent in
2009. This weakening fiscal position, along with other
factors, prompted S&P to downgrade Spain's sovereign debt
credit rating in January. Continued increases in
unemployment and contractions in economic activity could lead
to even tougher budget decisions for the government.

20. (SBU) POTENTIAL POLITICAL RAMIFICATIONS (QUESTION M):
Months of worse-than-predicted economic news have led to
widespread criticism of President Zapatero and his economic
policymakers for having downplayed the economic difficulties
long after many others were saying Spain was in a crisis.
Public skepticism has been aggravated by the failure of a
series of GOS measures to noticeably affect the slowdown.
However, two of the few factors in favor of President
Zapatero and the Socialists are that: (1) national elections
are more than three years away; and (2) popularity ratings
for Zapatero and the Socialists, albeit low, are still
somewhat higher than those for the scandal-mired opposition
Partido Popular. However, Zapatero suffered his first
serious political reverse since winning reelection in March
2008 when his party lost power in the March 1 elections in
the region of Galicia. Immigrants have been
disproportionately affected by the unemployment surge. The
GOS has unveiled repatriation measures for unemployed
immigrants wishing to return to their country of origin. This
program has had mixed success, but calls attention to a
growing social dilemma.

21. (SBU) CRITICISMS OF U.S. (QUESTION N): The GOS has played
up the responsibility of the U.S. subprime mortgage crisis,
and downplayed that of the domestic construction slump, for
Spain's economic difficulties. Several months ago, President
Zapatero was quoted as saying that the U.S. started the
crisis and Europe will have to fix it. However, the Zapatero
has not used that rhetoric recently, perhaps because of
desire for closer relations with the U.S. administration.
Instead, other PSOE officials continued to lay blame on the
U.S. during campaigning in advance of the March 1 regional
elections.

22. (C) EFFECT ON FOREIGN SECURITY POLICY (QUESTION O): The
2009 budget included decreases in the Ministry of Defense

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budget. This reduced budget means that acquisitions will
likely be constrained to force protection and high-priority
items, potentially limiting Spain's offensive
interoperability. On domestic security measures, the budget
situation has precluded the GOS from implementing port
security measures that it had planned in the prior budget.
Under last year's planning scenario, the GOS intended to
purchase additional x-ray cargo scanners and subsidize the
implementation of the Megaports radiation detection program
at several of its high-volume ports. Those initiatives are
now either being subsidized by other entities such as the
port authorities, or being delayed.

23. (SBU) EFFECT ON FOREIGN ASSISTANCE LEVELS (Question P):
On the broader international arena, Spain is concerned about
international issues of poverty and of food security, and has
pledged a goal of providing 0.7 percent of its GDP as foreign
assistance by 2012. There are no indications that this
commitment will be reduced, however, if Spain's GDP continues
to contract, then its foreign assistance level will also
contract.

24. (C) EFFECT ON NATO & GLOBAL PEACEKEEPING (Question Q): In
Afghanistan, the reduced budget means that there is less
leeway for costly projects like the Forward Operating Bases
under construction or in negotiations in Bagdhis province.
The economic crisis gives the GOS a viable excuse not to be
more forward-leaning on support for military operations that
the socialist Zapatero administration is already conflicted
over. As an example, Spain opted out of the NATO Allied
Ground Surveillance (AGS) System, pleading budget woes in
addition to ideological differences.
CHACON